I just posted two excellent essays by Mark Zandi. While oil has been hotly debated, it seems quite clear the current prices are NOT due to Y2K. Rising oil prices will contribute to inflation numbers, but alone are not enough to tip the economy into a recession. The equities markets remain overvalued. Despite the hyperbolic rhetoric about "bubble-dot-com," a serious correction will not necessarily end the economic expansion.

The real Achille's heel of the economy is lethal combination of debt and inflation. The Federal Reserve is glued to the inflation radar. Greenspan has given every indication of more interest rate hikes this year. These increases will fall onto an American economy where debt stands at astronomical levels. While most households can shrug off rising gasoline prices, many will find themselves hurt when interest rates climb. Increased costs for debt service will pinch heavily leveraged firms... as will the costs of a tight labor market. Can companies pass these increased costs to consumers? Some, perhaps, but the rest will be reflected in declining profit margins.

There are structural weaknesses in the current economy. Tight labor markets, recovering foreign economies and rising commodity prices will stoke the inflationary fires. The real question is whether the Federal Reserve can slow growth with stopping the economy in its tracks. This is a tricky business... and we'll probably have to wait until next year to make any judgements.

My prediction last year was a recession in 2Q/3Q of 2000. Unless the Federal Reserves fires some big bullets into the Bull, I doubt we'll see a serious economic downturn before 2001. As a contrarian investor, I have found some out-of-favor stocks with reasonable p/e ratios. Where are those people who told me I'd be wiping my backside with T-Bills this year? (chuckle) Andy?

There are those that argue the "new economy" are no subject to any of the traditional rules of economics... like supply and demand. This seems like arguing that aviation changed the law of gravity.

-- Ken Decker (kcdecker@worldnet.att.net), March 06, 2000

Answers

I agree that the factors of debt and inflation will be the major factors in triggering a possible recession. As to the severity of the recession, I'm not sure.

I too have heard from many regarding "paradigm shifts", and that "the rules have changed", that P/E ratios no longer apply. Nevertheless, I still use P/E ratios as a major factor when it comes to monitoring a company's performance and for investment purposes.

Perhaps many are investing in the dot coms due to their earnings potential, wanting to get in early before the price shoots up. This is, IMO, speculative investing. Nothing wrong with that, as long as one knows the risks. There was an article in Information Week earlier this year regarding stock options and internet startups, stating that 1 out 10 will eventually reach their earnings potential. Darn, I wish could've saved that article...I'll see if I can find it :-)

As long as one considers it a "risk/discretionary investment" and doesn't mind possibly losing the money should earnings not meet projections, no problem. The danger, IMO, lies for those who expect no or minimal risks when investing in dot com IPO's/startups...especially those who are heavily leveraged, or borrowing money to invest on a whim, or because they just see the price of the stock zooming up towards the stratosphere. My favorite motto is "Find out why, before you buy".

Personally, I not only look at the stock price and P/E ratios, but the management team, the market, and the ability to deliver dividends.

-- Tim (pixmo@pixelquest.com), March 06, 2000.

I heartily agree with all that you say. However, it is my opinion that the major factor will be the upcoming changing of the guard that will be upon us in under a year. The giant merry-go-round will be cranked up to full speed and many will be flung off into the mud. Hang on tight!

-- Sifting (through@the.rubble), March 06, 2000.

Since the wealth effect is helping to push this economy, is there any question that the reverse of the wealth effect will help to pull it down?

The DOW is more expensive than it was in 1929, Nasdaq is quite a bit more expensive than the DOW, and the .com stocks... well I don't know how to explain the internet stocks in rational terms.

The average investor is clueless about the risk of this market. Those that have some inclination about the risk have fooled themselves into believing that the Fed can't let the market crash, because it is "too big to fail". Greenspan has aided this misconception by his bailout of LTCM. He speaks, "irrational exuberance" but his actions say, "be irrationally exuberant, the Fed will bail you out".

On top of all that, the money supply just keeps growing and growing. At some point Greenspan will have to step in and defend the value of the dollar before this rampant inflation completely destroys its purchasing power.

What rampant inflation, you say?

Have you noticed lately how many dollars it takes to buy a company with no profits?

-- J (Y2J@home.comm), March 06, 2000.

Just some simple observations: People have been taking out 2nd mortgages to buy into the stock market. Some have been buying in with credit cards. Many live paycheck to paycheck and have no savings but lots of debt. The most popular car on the road is the gas guzzling SUV. Gas in my small town is $1.95 (reg/unleaded). Food has been increasing in price steadily since fall of last year.Good clothing has drastically increased in price over the last year. But there is no significant inflation.....and wallstreet will do fine this year......and there will be no recession?

I guess I'm just too simple to understand the "new paradyme".

nancy

-- NH (new@mindspring.com), March 06, 2000.

A topical link:

CNNfn Poll:
How high will the Nasdag go?

-- Tim (pixmo@pixelquest.com), March 06, 2000.

Nancy:

I think it was Hallyx who presented an article over the weekend stating pretty much what you just said. I'm beginning to feel like I just don't get out there enough, because I don't know any folks IRL who have done this. Then again, my friends don't tend to be in the 20-30ish group....more like the 40-50ish group.

I know LOTS of folks who lost their jobs last year due to Y2k freezes. It's been hard for them to find work. It's been hard for ANYONE who did mostly large system work to find work, and it's STILL hard. However, I haven't heard from ONE that they lost their home, lost their car, etc. We're all hanging in there because we had savings on which to rely. I SEE the SUV's on the roads, but I don't KNOW anyone who owns one. I also don't know anyone who took out a second mortgage on their home, let alone did so to invest in the stock market.

I'm certainly not saying that folks like this don't exist, but if one is lured by the promise of an easy buck and CHOOSES to spend every dollar one makes [versus the truly poor who MUST spend every dollar they make], isn't there faulty logic at play? Are there really so many folks who practice faulty logic?

-- Anita (notgiving@anymore.thingee), March 06, 2000.

Up until May of 1999, when anyone asked me about inflation, I said that all I had been seeing for years were deflationary pressures. No inflation in sight.

That changed. M3 growth in 1999 was nothing short of astounding. Europe pulled back from the brink of recession. Oil prices climbed. We shipped boatloads of dollars to Asia and they stopped hemmorhaging. Equity prices boomed.

While the gush of new money in 1999 was grossly immoderate, the Fed's efforts to contain inflation have been the picture of modesty. 25 basis points here or there. No draining of excess liquidity. This is Alan Greenspan's style. We'll be seeing a lot more of it.

Swami Brian says: Look for another 100 basis points rise by December. Signs of recession by late August, driven by slack sales in cars and housing. First recession quarter in Q4 of 2000.

Hey, ma! How'm I doin'?

-- Brian McLaughlin (brianm@ims.com), March 06, 2000.

Anita,

Yes, there are that many who practice faulty logic. After all, it wouldn't be right if you didn't have that new SUV; you would be the laughingstock of the country club if you showed up in an early 90s Honda Civic.

Materialism rules this country. Keeping up with the Jones's is infinitely favorable to running a tight financial household. I can always pay that credit card off next month.

The best thing that Y2K did for some people was to push them into analyzing their financial situation, and to realize that they are on a road to financial ruin.

There is a far cry in this country between what we need... and what we want.

-- J (Y2J@home.comm), March 06, 2000.

J:

How'd you know what kind of car we had? [grin] Seriously...we have the early 90's Honda Civic.

I thought country clubs were something shown to us on old TV shows like "Dallas". If folks need to use credit card debt to join them, I suspect they don't really "belong" there.

If folks need to second-mortgage their homes to put money in the stock market, THEY don't belong there either.

It seems that what you're saying is that SOME folks are willing to live a LIE, J. It's the old "welfare" Cadillac mentality spread to the masses. I just can't get too bent out of shape if folks who chose to live a lie are proven to be liars.

-- Anita (notgiving@anymore.thingee), March 06, 2000.

Anita,

We seem to basically be in agreement.

Only I would venture that it is a lot more than SOME who are willing to live a lie. This country has a NEGATIVE savings rate.

I do get bent out of shape about it, though. Not because their lifestyle will catch up to them and they will reap what they have sown, but because when it does, they will whine and cry until the government takes some more from me to give to them. If the government would stay out of the bailout business(at my expense), this would all be moot to me.

-- J (Y2J@home.comm), March 06, 2000.

There is "living"....and there is "living beyond one's means".

-- Tim (pixmo@pixelquest.com), March 06, 2000.

Anita and J,

Good conversation going on. I know exactly what you are saying, and thankfully I'm not living the "lifestyle" that you are talking about.

Some people probably think that we are already in a recession, while others are blinded by the Dow and Nasdaq. What I really wonder is, do the people that play in stocks really understand what it means when the Feds up the interest rate? I don't mean the heavy hitters, but the day traders and the people that put a second or third mortgage on their homes to dabble in the stocks.

As for me, I'll let the money that I have in the stocks just stay there. It may go up, then again it may go down. What I have in (which isn't much), is there for the long haul. But I'll continue to monthly add to my own savings. Thank goodness I am without debt.

-- (Donna@here.now), March 06, 2000.

Brian,

I agree with your observations on monetary growth. Those chickens will be coming home to roost.

With the current debt load in the public and private sectors, I think interest rates hikes will hurt. I also feel the public has become a bit spoiled about low rates. One can imagine how consumers will turn their noses at the first double-digit mortgage rates. A crash in housing starts and vehicle sales can ripple through the economy rather quickly.

Of course, since we agree I think your opinion is astoundingly accurate. (chuckle)

-- Ken Decker (kcdecker@worldnet.att.net), March 06, 2000.

A few recent items from Bill Fleckenstein's Contrarian column on Silicon Investor:

In the mania chronicles... Here's a perfect new-era pontification from one of the SI threads.

"I've got an enormous pile of dough in IRA's and Pensions. Much of it is invested in high-flying stocks, but some of it is in Treasuries and high grade bonds. I can raise a lot of cash in an afternoon, certainly in three days. So I have borrowed everything I can (flying credit card transfers at 2.99 % are the best). You would be amazed how many stupid banks will lend me money at 2.99 % on my name and perfect credit record.

"No decent broker in my experience will take a credit card check, but I launder them through my maxed-out home equity loan. Of course, my taxable accounts are all margined to the hilt, more expensive than credit cards and risky, because the credit card loans cannot be called (I just borrowed $25,000 for 6 years at 7.99 per cent, payback $600 a month, and freed balances can be borrowed again!) I told them that I had no intention of paying them back. The loan officer said `Fine. I like my commission on loans like this.'

"Despite all this stuff that scares the Countess half to death, I could cover any margin or debt call, but would only have to pay the tax on my IRA withdrawals. I am sure I am not the only or the biggest one using this perfectly honest scam. Someone ought to stomp on the banks making (expletive deleted) loans. Somebody stop me before I become a billionaire!"

In the mania chronicles... I want to share an email a reader sent me from a Yahoo message board about a speculation gone bad. We should point out though that this stock has split 2-for-1, so some of the numbers don't make sense. I can't vouch for the accuracy of this particular post, but if it turns out to be a spoof, I think the point survives. Because if things like this haven't happened already, unfortunately they will happen down the road.

"Took equity line equal to 125% of my homes value in May 99. Put money in my brokerage account, set up margin, went on margin 100% when athm was 175, rode it to 199 then all the way down to here.

"House was sold, fortunately it's a real strong market so was able to cover total 125% loan. Used balance of proceeds to pay off 50% of margin debt, of course the brokerage sold most of my equities awhile ago to cover the calls.

"I'm now working 2 jobs, and am moving back in with mom, with my wife who is 6 months pregnant. My wife is also working two jobs days at shoprite and nights at Rite Aid. She's making pretty good money but her feet are getting real swollen.

"We figure that we should be out from under in 3 years, or if athm gets to 200."

IPOs `R' Us... And in a late-breaking addition to the chronicles, my friend Colin Negrych emailed me the following:

"I went downstairs to Fifth Avenue to get a pretzel...and a rainbow-colored double-decker bus rumbled past me....with the following message plastered along its length: `IPOS FOR EVERYONE! EVERYONE CAN WIN! COME SEE US AT MAINSTREETIPO.COM!'

"The bus stopped a block down the avenue...and people came off the sidewalks on both sides of the avenue and surrounded the driver-side window asking questions. I cringed."

Zippy knows investing... "I am a Fund of Funds portfolio manager specializing in alternative investments (commodity trading advisors and hedge funds). Although my field of investing may be perceived very risky by most investors, the fact is, my field necessitates that I focus on accessing risk, understanding it and controlling it. As a result of my focus on evaluating potential returns relative to expected risk, my overall performance has significantly lagged the major stock indices over the past year, albeit with much lower volatility.

"Needless to say I've been getting pressure to enhance performance and improve the marketability of the products. I've been feeling very down about both my personal and professional investing performance and I had an experience today that just added insult to injury.

"I was dropping a package into the FedEx box in my building when the guy behind me, who was reloading the soda vending machine, said `Hey, so how's da market doin' today?' I responded that the Dow was down about 100, the S&P was down about 5, and the Nasdaq was up about 20. [Ed. note: Obviously, this was from a few days ago.] He responded `that ain't too bad, I don't care about the Dow, the NAS is where it's at. I'm in the NAS, I really like it!'

"I then said that I wouldn't touch the NAS with a 10-foot pole right now. He responded `that's if you're not in it already, but I've been in it.' I then walked away in disgust knowing that six years of finance study and 10 years of professional investment experience later, my performance is lagging that of Zippy the soda vending machine guy."

Whatever percentage of the population these stories represent, suffice it to say that they will be unpleasantly surprised to find, as Mr. Decker notes, that the law of gravity has not been repealed just because a few planes are currently airborne.

-- DeeEmBee (macbeth1@pacbell.net), March 06, 2000.

Anita and all, really excellent responses. The self-indulgent-I- deserve-it types do deserve what is coming. There are others though who are not near as sophisticated as you and think they are doing the right thing investing in the market---not understanding the faintest thing about interest rates, oil, no-earnings nasdaq stocks---and until recently they have been getting the go-ahead-and buy signal from the government. Just my thoughts, nancy

-- NH (new@mindspring.com), March 06, 2000.

Sorry, I missed that reference tag.

-- DeeEmBee (macbeth1@pacbell.net), March 06, 2000.

Today's installment of "In the mania chronicles...."

A reader sent in the following:

"My cousin is a chiropractic student in San Jose. Her college is right next to the Cisco campus. She came home yesterday and told me she had taken her tuition money and bought the Palm spin-off. She does not come from a wealthy family. She is 100 percent on loans and grants.

"All of her friends are taking their tuition money and doing the same. What is even scarier is that they are also trading penny stocks. Of course some of them are making money and are supposedly paying off their loans. I suspect they are not paying off their loans if they make money. If this isn't bad enough, she also told my mother and I that she and her friends are taking out low interest credit cards and opening trading accounts. Of course they are margining this amount as well.

"Mind you this is a person who doesn't watch TV or read. She literally does not know who the president of the U.S. is (she is Canadian, but she doesn't know who the prime minister of Canada is either)."

Last time I looked, share prices for both 3COM (COMS: Nasdaq) and its PALM spinoff were falling. COMS is about 40% off its recent highs and that oh-so-hot PALM IPO dropped from 160 to 80 in just a few days. Somehow I doubt that Mum and Dad will be pleased to hear that all that hard-earned tuition money has gone up in smoke. Looks like the cost of attending the School of Hard Knocks is as high as ever.

-- DeeEmBee (macbeth1@pacbell.net), March 06, 2000.

J:

You said: "I do get bent out of shape about it, though. Not because their lifestyle will catch up to them and they will reap what they have sown, but because when it does, they will whine and cry until the government takes some more from me to give to them. If the government would stay out of the bailout business(at my expense), this would all be moot to me."

HOW do you see this happening, J? The 80's experienced MASSIVE down- sizing of firms...laying off many people. Did the government pick up the tab? I've seen reports of Silicon Valley folks living in their cars because they STILL hope business to pick up there. Did the government help THEM? I've seen government step in to help corporations, but I've not seen it step in to help individuals who are out of work....or are you considering unemployment compensation or welfare? If you're considering unemployment compensation or welfare, do you really think those piddly sums will support house payments, car payments, etc.?

I guess I just don't understand how you think YOU'LL be the fall guy here for the irresponsibility of others ENMASSE.

-- Anita (notgiving@anymore.thingee), March 06, 2000.

Anita, You seem a little testy, has your welfare not arrived in a prompt fashion this month?

-- freddy flintstone (rush108@excite.com), March 06, 2000.

Freddy:

You're absolutely correct in that I haven't been myself lately. I'm concerned that my brother's prostate cancer moved outside his prostate. Unemployment pales in comparison.

Contractors don't get welfare, nor do they get unemployment benefits. I still have enough savings to last another few months, and the market is SLOWLY opening up.

I appreciate the concern, however. [HUGE COUGH.]

-- Anita (notgiving@anymore.com), March 06, 2000.

Northwest Airlines is postponing planned purchases of new planes because of the higher cost of fuel. If other airlines follow, there will be big layoffs at plane plants. Those people will not be making major purchases which could mean retail layoffs. this is the seed of recession.

-- John (littmannj@aol.com), March 06, 2000.

Warning: Weasel words to follow. This is an opinion only.

I think that we will get a half point rise in the discount and in the Fed Funds rates at the next FOMC meeting. Dr. Greenspan has the authority to ratchet them up prior to that, but that would appear to be excessive in the eyes of the market and would therefore cause a larger correction than is desirable at this time.

I also believe that this uptick won't get the job done and that it WILL be repeated again with the meet after that. This then will finally slow the irrational behavior being displayed by the DOW market, since the broader market is already rolling over as we type, and the overall market of equities has been in a slight selloff since April of 1999.

This then will at last kick the pins out from under the Dow.

This will happen at the same time that the market makers begin to see the ending of the productivity boost, and the resultant drop off of production, due in part to the overhaul and streamlining effects of the upgraded performance of the computer systems (increased efficiency), and to the run down of inventory which was accumulated prior to the y2k rollover.

This will cause the effects to be greatly amplified. The resultant, mostly unintentional, cascade effect will then feed into the selling and cause a near panic selloff to begin. This will be exaggerated by both the need for the Mutual Funds to liquidate to meet demand, and by the shoe clerks trying to bailout of their highly margined positions too.

The result will be a recession by 3Q 2000, and a Republican win in November. The recession will probably extend into the 3Q 2001, or possibly into the 4Q.

A really good buying opportunity should come in around Nov-Dec this year as the slaughter rips all stocks, jewel and dog alike. I'm staying in TBills for the moment.

This guess is as good as anyone's and is worth exactly what you paid for it.

S.O.B.

-- sweetolebob (buffgun@hotmail.com), March 06, 2000.

Anita,

I am truly sorry to hear about your brother. I am praying for him, and for you.

You and I and all responsible citizens like us bear the brunt of the foolishness of the masses. If your tax burden had not been so high, you would have been able to save more money during the fat times to tide you through the lean times. I am going through a fat time in my life now, but I am not so foolish as to think that there will not be lean times as well. My efforts to store up during the fat times are being thwarted at every turn by an oppressive tax system that takes from the productive members of society and redirects to those that are not.

We touched on this point in another thread, but I am a firm believer that the government should not be in the compassion business. Help is best administered locally, and the more local the better. Family, friends, church, and community is from where the help should come. It should NOT come by overtaxing the citizenry to keep them under control, then by wasting a bunch of money through bureaucratic mismanagement, and then by increasing the powerbase of the establishment by doling it out in return for favors. It matters not whether those favors be campaign contributions from corporations who have benefited by legislation, or votes from those who are permanent residents at the government handout trough.

-- J (Y2J@home.comm), March 07, 2000.

J:

Thanks.

I understand your concerns now. I don't SHARE them, but I understand them. Taxes have never bothered me much. IMO, there needs to be SOME way of obtaining monies necessary for stuff of which all folks benefit. Welfare has never bothered me much either, however, I DID appreciate time limitations being placed. The generation to generation of welfare recipients had gotten out of hand.

As much as I understand that the government needs to acquire money somehow, and as much that I understand how and why the welfare system began, I DO think that my 86 year old mother could do a better job spending the money. I'm MUCH more annoyed at paying a ridiculous price for a hammer or a study on bovine flatulence than I am with paying something to help feed some kids.

Anyway, I see now why you're concerned. Thanks again.

-- Anita (notgiving@anymore.thingee), March 07, 2000.

I know LOTS of folks who lost their jobs last year due to Y2k freezes. It's been hard for them to find work. It's been hard for ANYONE who did mostly large system work to find work, and it's STILL hard. However, I haven't heard from ONE that they lost their home, lost their car, etc. We're all hanging in there because we had savings on which to rely.

same in the UK if you're talking about IT staff, many contractors may not find jobs again if they're not internet-experienced (which most aren't over here having worked on legacy y2k.

-- Sir Richard (richard.dale@onion.com), March 07, 2000.